Summary: Precision Wires knows how to make money consistently, but is slave to the copper prices and its accounting policy. Moreover, the company’s interest expenses are about to increase due to recent Cap Ex projects it under took. Despite these two risks, the company’s stock is valued on the lower side and unless there is a 2008 like recession, there isn’t a great downside to the stock. There could be some more dip after Q2 and Q3 financials but not a lot. An investor can start accumulating the stocks in these levels in hope for a great return in a year’s time frame.  

My Holdings:

My Present Holdings
Avg. Purchase Price	Holding period	Highest Purchase Price	Lowest Purchase Price	Unrealized Profit/Loss
115.69	LT  1 Year	125	94.9	(19.61%)

 

About PRECISION WIRES:

The company is as pure a metal based company as they come. It takes copper, makes wires out of it and sells it to customers. Nothing more, nothing less! It has been doing so since 1989 when it was incorporated and listed in the Stock markets. As of now, it is the largest manufacturer of copper winding wires in the country.

PRECISION WIRES’s Ecosystem:

Precision wires sells primarily to Indian business.  Early all of its clients are manufacturers of electrical equipments which use these wires to make machines/motors/transformers/appliances etc. Most of the business is driven by how the Indian power sector and Indian manufacturing sector is evolving. The government of India is beginning to mold its policies to make them more manufacturing friendly and that bodes well for the long term implications for the sector.

The customers of Precision Wires make products that are in turn sold to other businesses. Those businesses, in turn, use these supplies to make their own products (transformers or Refrigerators or AC Machines or Motors) to sell them to eventual customers who can be both retail customers (for ACs or motors for e.g.) or government sector (for transformers for e.g.). This complete flow of products across this ecosystem means the following:

• Companies like Precision Wires are the lowest in overall value chain of manufacturing motors/transformers etc. Precision wire is a raw material provider for its customers. It has to tag the price of its products to the international price of Copper so that it is able to pass the increases to its customers. There is no other way it can bargain with its customers.

 

• In times where the prices of metals are about to decrease, the customers will prefer to keep less inventories to the extent possible and order in times of need. Where as in times when the metal prices are about to increase, the customers will want to keep their inventories at a slightly higher levels to make sure that their average costs are on the lower side.

 

The above dynamics plays each time there is a tangible shift in the price of copper. This behavior has an immediate short term impact on the finances of companies like Precision Wires as they have to stock their inventories and change the operations accordingly.  Apart from this impact, one can assume that wiring companies like Precision Wires should operate on consistently tight margins as their prices are directly proportional to the cost of metals.

PRECISION WIRES’s position in its ecosystem:

The Company sells to a lot of SSIs (Small Scale Industries) and so its customer base is not dominated by a concentration of big names. That can both be good and bad. The good thing is that the fortune of the company is not dominated by a few key names who can dictate terms. The bad thing is that the company needs to sell to a highly disorganized market that is extremely sensitive to the general economic condition and the government’s manufacturing policy.

To understand whether it is net good or net bad for Precision Wires, one needs to look at its history. In the past 6 years, the company did terribly in 2008 when the economic conditions were at their worst. That year, the company earned just 1 Rs. per share. However, the company bounced spectacularly the next year when the EPS was above 19 Rs. per share which was even more than 2007. This leads us to believe that in bad times the company tends to do worse and in good times, it does excellent business. This behavior is also an output of the company’s accounting policies (documented later in the article).

 

In terms of pure wiring companies, Precision Wires is the 6^th biggest wire manufacturer in India. Below table contains the names of the top wire manufacturers in India arranged by the descending order of their average gross sales over the last 3 years.

 

Company Name	Average Sales
Havells India Ltd.	2697
Sterlite Technologies Ltd.	2401
Finolex Cables Ltd.	1805
Kei Industries Ltd.	1096
Diamond Power Infrastructure Ltd.	784
Precision Wires India Ltd.	767
Universal Cables Ltd.	586
Ram Ratna Wires Ltd.	441
Paramount Communications Ltd.	427
Nicco Corpn. Ltd.	332
Cords Cable Inds. Ltd.	262

 

Based on the above 2 points, I can say that Precision Wires is sufficiently big to be able to counted among the significant players in the country but at the same time does not exhibit the underlying resilience of a big company. The company has been making profits consistently but there is a huge variation in its performance. On the whole, one can say that Precision Wires’ position in its ecosystem is significant, but not secure.

 

Accounting Policies:

For a company that buys metals, converts it into wires and sells it off; the whole idea of profit is dependent on how much the metal did cost in the first place. If the cost of base metal when it was bought was high but the general cost of metal when the wire is sold in the market is low, then the profit purely depends on how the original cost of metal was documented. In this regard, Precision Wires has a challenge. It documents its inventories on a FIFO basis. This means that the cost of metal that goes into production is assumed to be the cost at which it was bought originally. In other words, if the cost of metal is increasing worldwide, then by the time the metal goes into production floor, its cost in outer market is more than in company’s books. When the piece of wire thus manufactured is sold I market, the price the company gets is on the higher side. In other words, the profits are artificially inflated to that extent. Exactly the opposite happens when the general cost of metals goes lower. The cost of metal that goes into production is higher than the market and so the company makes artificially lower prices.

 

Ideally, Precision Wires should adopt a Weight Average Costing of its inventories as its sale price and sale quantity also follows the general price trends in the market. Given that the company is following FIFO, it is not hard to understand now why the performance is very bad when the conditions are unfavorable and why it is very good when the conditions are favorable.

 

In this light, the upcoming trend of copper prices is the key to Precision Wires’ performance in the coming months. If the prices of copper are about to decrease, then the performance of the company is going to be relatively poor and if the prices are about to increase then the performance of the company is going to be that much better. This is a general guideline under which we should evaluate this company.

 

Reported Financial Performance: The in the last FY2010-11, the company’s total revenue and PAT increased on a YoY basis.

Below is a high level view of the company’s finances as reported in its annual report. It can be seen that the profits have improved rapidly in the last 3 years and in the same time the worldwide copper prices have also increased significantly.

FY	2008-09	2009-10	2010-11
Net Sales (Rs. Cr)	537.14	630.27	873.31
Reported pat (Rs. Cr)	1.16	22.62	31
Average Net Worth (Rs. Cr)	141.76	150.13	169.91

 

 Free Cash Flows to Equity Owners:

Along with the above finances, one can look at the below measures from the company’s annual financial statements.

FY	2008-09	2009-10	2010-11
Cap Ex	3.09	-4.13	20.87
Dep + Amortization	10.32	10.88	12.25
Absolute change in Non-Cash W/C	13.06	-7.82	-28.1
Total Increase in Debt	-13.86	-6.16	18.49
Total Increase in Deferred Tax Liability	0.74	1.49	0.46

 

One can see that the company has invested heavily into Capital Expenditures in the last year. As per its own annual statement, it is a drive to increase capacity to prepare for good times to come. It is hard to fault that statement and the preparation as we have concluded above that the times are indeed going to be good for the metal based companies supplying to Indian manufacturers and Indian Power industry.

The company has financed the apex using Debt as there has been a similar increase in debt in last FY as well. With increasing interest rates, that is going to put some pressure on its cash flows. This aspect, hence, is slightly negative. In order to remove the impact of debt, one has to normalize the Debt across previous years.

The non-cash W/C status of the company also changes sign each year. The absolute amount of change is also not small in the bigger scheme of things and so one has to normalize this factor too to understand its impact on the company’s financials.

When I normalized the above factors and calculated the FCFE, I get the following data (all amounts in Rs. Cr.):

Average last 3 FY Sales	680.24
Net Profit (latest)	31.00
Cash Value	27.99
Latest FCFE after Normalization of Debt and Capex	15.52
Latest FCFE before Normalization of Debt and Capex	14.51
Average FCFE after normalization for the past 3 years	18.29
Average FCFE before normalization for the past 3 years	16.78

 

Clearly for PRECISION WIRES, one can see that its Free Cash Flows on a 3 year normalized basis 60% of what the profit is. This depression is entirely due to the CapEx project the company took last FY.

 

Fit vs Flab:

In the last FY its interest coverage (the parameters that tells us how much money is left after mandatory obligations are paid) was at a healthy 10.85 This indicates that the company has good enough earnings over and above its mandatory obligations, and that is a good thing. However, one should know that this is because a) the profits were artificially inflated due to the inventory costing issue discussed above and b) most of the debt was taken to finance capital expenses and that does not contribute to the interest expense and hence the interest expense is also lower to the same extent.

Net-net, one can say that the interest coverage for Precision Wires is an indicator of false happiness.

To gauge the health of the company, let us compare its current assets to the current and total liabilities. In this regards, there is a sign of relief. One can say that the company’s current assets not only far exceed its current liabilities but also its total liabilities (current liabilities + long term debt). That is only a good thing as if a time comes when the company has to be auctioned, the liabilities can be paid off without touching any of the fixed assets. The promoters are sleeping peacefully.

Based on above, I believe Precision Wires is fit to survive the vagaries of its industry, but it has to follow a very tight balancing act. The company and its investors cannot have a false sense of security.

Ownership Structure:

59.65% of the company is in the hands of its promoters. This is not ideal under normal conditions; as if the company performs poorly then it will be difficult for someone else to buy it. Having said that, one advantage that comes with a company that has high promoter holding is that such a company prefers to pay handsome dividends (as dividends are tax free in India). Hence, if the company is making money consistently and over a long time, then it can be said that its ownership should not be an issue.

In this regards, we see that Precision Wires is making consistent Money (3 years free cash flows) and has been in the business for a long time (since 1989).

Based on this, I can say from a lay investor’s perspective that that the ownership of about 60% is not ideal, but can be tolerated for Precision Wires.

 

Return on Net Worth: 

The PBIT/Avg. Net Worth for PRECISION WIRES was 31.4% 6 years ago. It was 30.5% in the last FY. In this time, the lowest it got to was 4.1% in 2008 but apart from that it did not go below 23% anytime. In the last 6 years the prices of copper have changed both ways but the company’s performance dipped only when the recession disaster struck in 2008. The worldwide metal prices were very low and the historical costs of the company were very high and as a consequence the profits took a hit.

 

Based on this statistic alone, one can say that the company HAS GOT the formula to make good money in general economic conditions and is using that formula wisely.

 

Value Judgment:

Till now the I have mentioned the risks in the company. However, no company that is making consistent profits is bad enough that its stock is worth 0 Rs. In that regards, I compare the price of the company with both its profit and its free cash flows. Also,  the company has a small amount of Cash in hand. This is OK as a manufacturing company need not be cash heavy. I remove this cash amount from the share price of today. By doing so, we get the following nos:

Company	Precision Wires
Latest BSE closing Price	93.5
P/E Reported	3.5
P/FCFE Updated (After Normalization – Latest)	5.2
P/FCFE Updated (Before Normalization – Latest)	5.5
P/FCFE Updated (After Normalization – Last 3 FY Avg)	4.4
P/FCFE Updated (Before Normalization – Last 3 FY Avg)	4.8
P/Trailing 4 Qtr Earnings	2.7
P/Bv	0.64
Current Assets > Current Liabilities	TRUE
Interest Coverage	10.85

 

The company is trading at 4.8 times its last 3 years average free cash flows (which is on a very low side) and is trading at 36% discount to its book value (which is again on the lower side). As per the analysis earlier in the article, there are risks with this company due to its size and its accounting policies on inventory costing. Even though I believe the risks are real, I don’t believe they are as grave under normal conditions as reflected by the price. The only way the very low price of the stock can be justified is by saying that may be that the general market is assuming a 2008 like situation in the short term.

I am no expert on how the copper prices will span out. The way I see it, copper prices are indicative of the growth in world economy. If the economy is on an upswing, copper prices will increase and Precision Wires will do very well. If the world economy tanks, so will copper prices and so will Precision wires. So net-net, the outlook on Precision Wires is directly tied to the outlook in world economy. Other than that, there is another concern with the company’s finances that its interest expense is likely to increase when its capital expense projects are over. This is a constant irrespective of prices of copper.

On the basis of this, in terms of its stock price I can say that:

• In case the world economy tanks in the next year or so, there is still a lot of downside possible for Precision Wires.  That will happen if Greece issue is not solved or if Europe is under a prolonged crisis.
  • Even though I am no expert, I know that copper prices are largely dictated by how much manufacturing China does. Europe is China’s leading partner. So if Europe does not recover, it is likely that China won’t need that much copper.
  • Also, there is a separate trend when China is trying to cool its economy. That too does not bode well for copper.

 

• In case the world economy does not tank but lingers along, then the prices of copper won’t take any more hit but the finances of Precision Wires will due to the interest expense. In that regards, there is not much downside to stock price as the price is already on the lower side given the present situation.
  • Personally, I believe that Q2 and Q3 financials of the company will be on the lower side because world copper prices started to go down in this time and stock may go down a bit more. But that will be very short term.

 

• In case the world economy improves, then the performance of the company will be great and that of stock price spectacular.
  • Personally, I believe this is what I think will happen in the next year or so.

Verdict:

Investing in Precision Wires is relatively less risky at present levels. For a patient investor who is willing to look longer term, this is a good opportunity. Even though the stock is undervalued, the under valuation is justified to some extent. I would personally look at this stock as an “accumulator” which means I will keep on accumulating this stock on these levels with hope of a good payback a year hence. Personally, I have unrealized losses in the scrip but I am going to invest more.

Personal Note on PRECISION WIRES:

When I first analyzed Precision Wires, I only took a note of its finances and on the basis of free cash flows, I concluded that the company is great to invest in. I had peacefully ignored the advice of experts who were advising a move away from Metals. I thought, if I have to invest in one Metal company, then this will be it. I was right and I was wrong. As of now, I see that I was more wrong than write. It is no doubt that the company has discovered the key to make money consistently and is one of the better companies to invest. However, I was wrong when I overlooked the market conditions and did not look at the accounting policies of the company. When the market tanks then even the best performers tank.

Lessons learnt:

• Pure play metal products companies are slave to their accounting policies and the world economic conditions.
• If a commodity based company tanks more than you anticipate, it is most probably due to something in the accounting policy that you may not have observed earlier.